Behind the Headlines Israel’s Economic Woes

October 30, 1984

WALTHAM, Mass (Oct. 29)

Israel is trapped in a web of conflicting economic forces in its struggle to cope with an ailing economy, according to a Brandeis University economist who says solutions to one problem often exacerbate others.

“Israel today is faced with the problems of mounting foreign debt, high trade and budget deficits and 400 percent inflation,” says Robert Lerman of Brandeis’ Heller Graduate School. “Because of the intermingling of so many things in Israel’s economy, it’s difficult for them to cope.”

For example, governmetn cuts in price subsidies will initially reduce government spending. But by raising market prices, they also will raise wages and interest on government bonds because both are indexed to the cost of living.

Devaluing the currency, the traditional way countries deal with trade deficits, also fuels the inflation cycle in Israel because of the link between prices and wages.

“When you devalue, you raise the price of foreign goods,” says Lerman. “That is reflected in the cost of living and thus it increases wages, which force Israeli companies to raise the price of their own goods.”

Meanwhile, says Lerman, Israel’s foreign debt and trade deficits are diminishing the country’s ability to grow, and “they create the danger of larger and more serious economic downturns.”

BACKGROUND OF THE CURRENT PROBLEMS

Lerman traces Israel’s current problems to economic practices that developed and were appropriate during the nation’s first two decades but now have Israel “living beyond its means.”

“For a new country intent on growing, it made sense to borrow abroad, to use foreign capital to supplement internal resources for investment,” says Lerman. “It especially made sense for Israel, given its ability to draw on such resources as world Jewry.”

Lerman says that even though Israel spent more than it produced during its first two decades, “the foreign debt position wasn’t negative; it was a strategy for growth.” Then, with the Yom Kippur War in 1973, “there was a large increase in military imports and a large rise in oil prices.”

Unlike many other countries, Israel didn’t respond to rising oil prices by cutting consumption. Consumption was allowed to rise, says Lerman, and this was financed by foreign borrowing. “Starting with this period, Israel’s balance of payment deficits were no longer primarily financing growth,” he says. “They became unproductive deficits.”

In addition, “the share of Israel’s deficits financed by grants and long-term concessionary loans from abroad began to decline, and more and more of the deficits have had to be financed by expensive short-term borrowing.”

For example, Lerman says Israel owed $3.3 billion in 1970, with about $600 million of that in short-term debt. By 1980, Israel’s debt had grown to $22 billion, and $9.6 billion was short-term.

“The problem now is that while everyone recognizes the long-term issues — the growing debt and the burden of repayment — there are many differences of opinion about what to do,” says Lerman. He says the differences result from concern over Israel’s “super inflation” and relationships between the various elements of the economy. “The fundamental issue now,” says Lerman, “is whether to give priority to bringing down inflation or reducing the balance of payments deficit.”

Without improvement in Israel’s balance of payments, the country risks a serious decline in living standards, increased unemployment and the possiblity of emigration, Lerman says. “But efforts to deal with the trade baleance directly without dealing with inflation can fail, as they have in the past.

“It’s not entirely a matter of people knowing or not knowing what to do, but Israel is in a box that is very difficult to extricate from.”